Wednesday, May 7, 2008

Discerning the Pattern

Hyperinflation has happened before, quite a few times. For that matter it's happening in Zimbabwe right now. Given that this is not a unique phenomenon, we should be able to learn from past data.

Looking at the historical record, there does seem to be a pattern to hyperinflation:

1. Slow Climb: 6 months to 2 years
2. Ramp-Up: 2 months to 1 year
3. Crazy: 1 month to a year
4. Currency Nuked: 1 day
5. Recovery: 6 months to years

In more detail:

1. Slow Climb: This is arguably "normal" inflation, but with a noticable upturn. By itself it doesn't guarantee hyperinflation, as inflation typically fluctuates anyway, but I have not found a case of hyperinflation that started with deflation. So an uptick in "normal" inflation may be a red flag that something bigger is on the way. Approximate time scale is 6 months to 2 years.

2. Ramp-up: This is the transition from "normal" inflation to something unusual. In this phase, the majority of people start changing their spending patterns due to inflation. It starts significantly affecting economic behavior. Approximate time scale is 2 months to 1 year.

3. Crazy: Full-fledged hyperinflation is truly crazy. This is the Weimar Republic, wheelbarrow full of money to buy a loaf of bread phase. There is no mistaking this one. The primary economic effort will be getting rid of your cash as fast as possible. Got money in your bank account? Wrong! Get rid of it now! Buy stuff as soon as you get paid, otherwise your paycheck is worthless by next week. Better hope your employer starts making COLA increases for each paycheck. This could last perhaps 1 month to a year.

4. Currency Nuked: Inevitably, hyperinflation is halted by revaluing the currency. There is no time scale to this, you just wake up one morning and bam! The Central Bank (The Fed in our case) puts the hammer down and says "The value of the currency is now [whatever]." It's that [whatever] that is critical. Often they will simply issue new currency at, say, 1000 times the value of the previous currency, and call it "New!". The "New Peso", the "Rentenmark", the "New Dollar", whatever. This is not a revaluation, it's just shifting the decimal point and it doesn't solve the underlying problem. Argentina tried this several times. The key to nuking the currency is to tie it down to something of real value. In the Weimar Germany, with typical German efficiency, the currency was revalued only once by tying it to a mortgage on all the land in Germany.

5. Recovery: Nuking the currency doesn't necessarily solve everything. There will be instabilities and hyperinflation could even start over again. Or you can get a recession. In the end, the solution is always for the government to maintain a sound, stable, and sustainable monetary policy while the economy sorts itself out. Recovery can happen fairly quickly (6 months), or could go on for years.

At this point, I'm not sure if we're in phase 1 or 2. Feedback is welcome.



M. Simon said...

The uptick in T-bill rates along with the spending spree causing no change in the predicted jobs pattern is covered at Unstimulating.

The beginning of the slow climb is well underway. I'd say 4 to 8 months before phase 2 kicks in.

OTOH just think of what hyperinflation will do to the velocity of money.

ZenDraken said...

4 to 8 months sounds about right, which puts us between the medium and long-duration scenarios. That would give us this medium/long schedule:

Slow climb: (already happening)
Ramp up: Sep 2009
Crazy: Jun 2010
Dollar Nuked: Sep 2010
Recovery: Sep 2010 - Mar 2012

This will make for an interesting Congressional election period.

Anonymous said...

Well, then the key will be to determine if we are really going to experience phase 2.

September, huh!

LarryD said...

Part of what we're seeing is people anticipating inflation. China adjusting it's portfolio of Treasuries with more emphasis on short term rather than 30 year maturity. And being less interested in buying Treasuries at all (hence the uptick in T-bill rates). More interest in gold, etc.

People are looking at US Government projected spending, see it as unsustainable (not to mention all the money creation already done), and are positioning themselves for the inflation they see as inevitable.

This could throw off the schedule.

Anonymous said...

Has anyone done a comparison based on the sheer size of the American economy as comparison to some of these other cases. I do happen to believe that we will experience inflation or perhaps hyperinflation, but my question is that with an economy the size of the U.S. economy, might not the effect be a bit slower to see. Kind of like the Titanic being so slow to turn/accelerate/decelerate. Might these phases not be of extended duration?

ZenDraken said...

Anon: I don't know of any such study, but I don't think the size of the economy is as much of a factor as how quickly newly-created currency disperses into the system as a whole.

In theory, if you double the amount of money in the system, everything will suddenly cost twice as much. That's an oversimplification, caveats apply, etc., but that's the general concept.

There are certainly many other factors. A reduction in supply or increase in demand will also drive prices up. But all other such factors being held constant, if you dump a lot of currency into the system, prices must go up. The question is how much gets dumped and how fast does it disperse?

I can't answer that question, but I think in this day and age we know that money can disperse quite rapidly.